Reason Foundation

Are the Mortgage Servicing Settlement Talks Dead?

California backing out the mortgage servicing settlement talks dealt the prospect of a multi-state agreement between the top five mortgage servicers and state attorneys general a near deathblow. AmericanBanker cited a number of industry experts as pointing out that it is unlikely the banks will come to terms with the AGs without New York or California on board (two of the most troubled mortgage states). But the servicers don’t want to fight every state individually any more than the states want to bring 50 attacks on the servicers. So are the talks dead?

When we first started writing on the story of mortgage servicing settlement talks last year, the state attorneys general had gotten off to a strong start. Fresh off the robo-signing scandal, they had the upper hand in negotiations with the threat of mountains of litigation that banks would want to try and remove liability for even at high cost.

But the state AGs got greedy, tried to go beyond just ensuring restitution for those families who have been wrongly foreclosed on (there have been just a few dozen confirmed cases), and the banks balked at their demands—both because of the extortion-level dollar amount of the settlement proposal, as well as the demand that servicers break contracts with backdoor cramdowns (modifying a mortgage without the consent of the investors who ultimately own the mortgage).

The negotiations have dragged out, and the AG coalition has fractured. A couple of proposed deals that were leaked to the public were widely panned, and goals of the coalition appeared to drift.

Then, in late August, New York attorney general Eric Schneiderman was unexpectedly and publicly kicked out of the coalition, as lead negotiator Iowa AG Tom Miller accused him of undermining the talks. Schneiderman had been demanding an ever broader deal than the wide net that had already been cast, hoping to loop investor claims into the settlement price as well and kill three or four birds with one stone.

But the point all along is that the mortgage servicers lost their way in adhering to the legal code on collecting payments and processing foreclosure rights in the case of delinquencies. Many of those errors have been in the process of being fixed in the interim anyway, though state AGs still have a number of outstanding legal claims they can press that the banks want to clear up with a settlement.

It should be clear that if the states and servicers settle on just the mortgage servicing issue, that will not preclude the government from prosecuting the banks on other legal violations, including the recently launched FHFA lawsuit claiming banks deceived Fannie Mae and Freddie Mac. With that in mind, Tom Miller was not necessarily in the wrong to give Schneiderman the boot if he really was undermining the ability to get a narrowly focused deal.

But that may ultimately not matter now that California has withdrawn. The Golden State AG Kamala D. Harris broke off the talks because she felt where the deal was heading was “inadequate for California homeowners.” In a letter she wrote:

It became clear to me that California was being asked for a broader release of claims than we can accept and to excuse conduct that has not been adequately investigated. […]

In return for this broad release of claims, the relief contemplated would allow too few California homeowners to stay in their homes.

The complain underscores one of the more problematic attitudes in the wake of the housing bubbles crash, that which seeks to artificially perpetuate homeowners in mountains of debt in homes they couldn’t afford in the first place. Banks have been modifying and refinancing mortgages for those that can demonstrate the financial ability to make it a good idea to keep the homeowner in their home. But in many cases families will need to move in order to remove the current burdens placed on them by being an overpriced house without the ability to repay the people who gave them money for the house in the first place via being shareholders or debt holders of a bank that issued the mortgage.

Despite California dropping out, Miller intends to press on with the agreement, which will then be offered all states, including California and New York, which can all choose to accept or not. A source at one of the top 10 banks in the U.S. told me this week that he could foresee the mortgage servicing talks continuing, since it is in the interest of the banks to get this settlement done and the liabilities behind them. But, that doesn’t mean they’ll be bullied into paying a $20 billion pound of flesh, since the legal costs of continuing the negotiations are much smaller than that would ever cost them.

The one other thing to watch will be if Washington can negotiate a settlement of some kind with the servicers. The Department of Justice and bank regulators, including the CFPB, are also investigating the mortgage servicing issue and have legal claims to press. It may be that they are able to find a settlement palatable to all sides.